By Patrick McKeough, TSInetwork.ca
Special to the Financial Independence Hub
Tip of the week: “When you work out a plan for your retirement, make sure that you aren’t basing your future income on over-optimistic calculations that will end up leaving you short.”
Every year as RRSP season heats up, many investors are confident they are taking concrete steps toward a secure retirement. But are those steps based on realistic calculations?
Let’s say you’re 50 and you want to retire at 65. You have $200,000 in your RRSP, and you expect to add $15,000 in each of the next 15 years. To determine if this is enough to retire on, you need to make assumptions about investment returns and income needs.
• What you can expect
Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. For purposes of this retirement plan, we’ll assume a 6% yearly return, and disregard inflation. Your $200,000 grows to $479,312*, and your yearly $15,000 RRSP contributions add up to $370,088, for total retirement savings of $849,400.
(*Be sure to check your math. There are many compound-return calculators available online. For example, you can find a comprehensive compound-return calculator at the Bank of Canada’s web site.
• Income and outgo
If you continue to earn 6% a year, and you withdraw $50,964 a year (6% of the $849,400 in your RRSP), you can avoid dipping into capital until your mid-70s, when RRIF rules call for steadily rising withdrawals.
However, if you start taking money out faster, or earn lower returns, you’ll run out of money. If you withdraw $90,000 a year while earning 6%, the money you’ve accumulated will last just over 13 years. If you earn 5% but withdraw $90,000 a year, your money will be gone in just over 12 years.
• Beware of getting caught in a vicious circle
Some investors, worried about their money eroding, or tempted by even greater gains, start to look for higher returns in riskier investments. They may take a chance with gold and silver stocks or even with high-risk junior stocks. In years when these volatile investments lose money, those investors will then have less capital for the following year. This may lead to a vicious circle of lower income and shrinking capital.
Our investment advice
Rather than taking on extra risk, we always advise investors to take the safe route to retirement planning. Save more now, work longer, or plan to spend less. Retirement leaves you with lots of free time, and filling it often costs more money than people anticipate. But postponing retirement, or working part-time as long as you’re able, can pay off in higher current income, more contentment and greater long-term security.
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books.